Steer clear of these three behavioural pitfalls during bull markets

Most of us think that it is easy to participate in bull markets and make good returns. Surprisingly though, many investors don’t perform well even during a bull market, thanks to three behavioural mistakes. Panic selling at all-time highs, procrastination in deploying new money and panic buying. Here is how you can avoid these mistakes:

Panic selling at all-time highs

Whenever markets hit an all-time high, it’s normal for investors to feel uneasy and consider selling equities in anticipation of a fall. But, here is why this maybe a bad idea. All-time highs are a normal and inevitable part of long-term equity investing. Without all-time highs, equity markets cannot grow and generate returns. Sample this. If you expect Indian equities to grow at say 12% per annum (in line with your earnings growth expectation), then mathematically it means the index will roughly double in the next 6 years, become 4X in the next 12 years, and 10X in the next 20 years.

In other words, the index will inevitably have to hit and surpass several all-time highs over time if it has to grow as per your expectation. For the last more than 23 years, the average one-year return, when invested in Nifty 50 TRI (total returns index) during an all-time high, is ~14%!. So all-time highs in isolation don’t imply a market fall and, in a majority of the cases, market returns have been strong post an all-time high. To avoid this mistake, stick to your asset allocation and rebalance your equity allocation if it deviates more than 5% from the original allocation.

Procrastination in deploying new money

When you have new money to invest, but the markets have already gone up, you might feel tempted to time the market by waiting for a correction. However, this seemingly simple decision is more complicated than it appears.

The more you think of these questions and add a “What if…” to the mix, you suddenly realize that what initially looked like a simple decision is far more complex than you thought.

Say you have to deploy ₹10 lakh but as you stay waiting in cash, assume the markets go up by 10%. This opportunity loss of ₹1 lakh may not seem significant now. But when you assume 12% returns over 20 years, that translates to 10 times in 20 years. So the cost of this missed ₹1 lakh over a period of 20 years at 12% returns is almost ₹10 lakh!

Thus, these seemingly small mistakes can accumulate over time and significantly impact your long-term outcomes.

Peter Lynch, the famous investor, sums up this problem aptly —“Far more money has been lost by investors trying to anticipate corrections, than lost in the corrections themselves.”

The solution lies in building a rule-based framework for deploying new money, and combining lump-sum and staggered investments over 3-6 months, depending on market valuations. When valuations are high, stagger a larger proportion of the money, and vice versa. If you find it difficult to build a valuation model on your own, use the equity valuation of any proven valuation-oriented dynamic asset allocation fund as a proxy. The equity exposure indicated by the fund can be the proportion of new money to be invested immediately and the remaining can then be staggered over 3-6 months.

Panic buying

In a bull market as discussed above, a lot of investors attempt market timing by delaying new investments or taking out some money with the intent to deploy that after a market fall.

More often than not, the market tends to surprise them by going up further. Even if there’s a market fall, many still don’t invest as they usually extrapolate the fall and convince themselves that - “It looks like it can fall more. I will wait and invest”.

Once you miss the upside, the wait for a fall gets frustrating and eventually at much higher levels the ‘fear of a fall’ is replaced by ‘fear of missing out on further upside’. Inevitably you give in.

But since you missed the upside so far, you try to compensate by excess risk taking. This takes the form of increasing equity exposure much above original asset allocation, chasing recent performers, taking sector bets, higher small-cap exposure, trading, etc. How this story eventually ends is familiar to all of us.

The key, as the market continues to go up, is to resist the temptation to take excessive risks. Stick to your original asset allocation and look out for bubble market signs (insane valuations, late stage of earnings cycle, euphoric sentiments, very high past returns, huge inflows, lot of new investors entering, craze for initial public offerings, media frenzy, etc.).

Summing it up

To successfully navigate a bull market, keep an eye out for these common behavioural mistakes, and remember to stay humble, resist the urge to time the market, and avoid taking on excessive risks.

Arun Kumar is vice-president and head of research, FundsIndia.